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Budget Windfall Underpins New Czech Government's Spending Plans

(Bloomberg) -- Czech Prime Minister Andrej Babis’s parliamentary confirmation this week cemented his rule over one of Europe’s most stable economies, and he’ll now try to deliver on promises to boost spending in areas ranging from roads to teacher salaries.

A combination of rapid economic growth and record-low unemployment mean the country is running one of Europe’s biggest public-finance surpluses and smallest debt burdens. That should provide room to boost pensions and public wages as the nation of 10.6 million seeks to bring income levels closer to those in western Europe almost 30 years after the fall of the Iron Curtain.

"Czech infrastructure is massively underfunded, leaving a lot of room for meaningful public spending that would, in the longer-term, benefit the economy and the budget," said Viktor Zeisel, an economist at Komercni Banka AS.

While a deepening shortage of workers is a headache for Czech companies, it means more tax revenue and less spending on unemployment benefits. The economy has more vacancies than job seekers and its 2.3 percent unemployment is the lowest in the European Union.

Strong finances also underpin Babis’s plan to step up investment in transport infrastructure, hospitals, schools, and retirement homes. He has proposed to raise the state’s total capital expenditure next year by 30 percent to 144.2 billion koruna ($6.5 billion).

A spending boost is badly needed in a country that still lacks a highway link to its southern neighbor Austria. A rail trip from Berlin to Vienna via Prague takes about an hour more than a route that’s a quarter longer but avoids the country altogether.

The Finance Ministry’s central-budget plans through 2021 show the state will need to borrow money to pay for some of the projects. Resurgent inflation and central bank interest-rate hikes have increased the government’s funding costs above levels seen in Spain and Portugal, which both have worse credit rating. Czech yields were among the world’s lowest just a year ago, but the premium on the five-year government bonds over German securities is now the highest since the peak of the global financial crisis in 2009.

While the broader public finances are in surplus, a spending surge that began before October elections has tilted the central government budget into a deficit. The Finance Ministry projects 50 billion-koruna shortfalls in each year from 2018 to 2021. Critics say the state should instead use the present boom period to generate surpluses that could be used to stimulate the economy during a future downturn.

"Exceptionally high tax revenue means the government can now afford to raise public-sector salaries, which will in turn put pressure on wage growth in the private sector," said Zeisel. "But it’s unsustainable in the longer term."